ps1_answers - 14.02 Principles of Macroeconomics Problem...

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1 14.02 Principles of Macroeconomics Problem Set # 1, Answers Part I 1. True: The labor supply curve will shift up-left and a new equilibrium with a higher real wage will exist. This is, in part, due to the pro-cyclical mark-up assumption. 2. True: If we keep all other variables constant, a contraction in fiscal policy decreases GNP in equilibrium, which decreases investment. A more sophisticated answer to this question could consider the effect of fiscal policy on other variables that we would otherwise consider exogenous. For example, we could include the effect that changes in fiscal policy have on the behavior of the Fed. In this case, if the Fed cuts interest rates (to make sure the cut in spending doesn’t lead to recession), then this will have a positive effect on investment, and might dominate the first effect. 3. True: It is important to note that, without any further assumptions or considerations, the whole of the profits of the firm are income that eventually turns out in the hands of the households. (a) Final value (200) = the value of sales to consumers (200); (b) The added value (140) = the value of the final goods (200) minus the value of the intermediate goods (60); and (c) The household income (140) = wages (50) + profits (90=200-50-60). 4. True: A policy variable like military spending is a given variable, and therefore by definition, doesn’t have a behavior equation in the model. Again, a more sophisticated answer could consider the effect of the situation in the economy on military economy. This last consideration requires that we “model” the behavior of military spending to change the character of this variable from exogenous to endogenous. 5. False : In this case, the balanced budget multiplier is one. Note that the negative effect of T on the aggregate demand is mitigated by the MPC while the change of G has 1:1 positive effect on the aggregate demand. 6.

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ps1_answers - 14.02 Principles of Macroeconomics Problem...

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